All customers are not equal. Customer value can vary dramatically, and we helped one client, a credit card processing bank, discover this fact.
We helped the bank determine that supermarket and airline customers, for example, are better customers to have. Why? They have high volumes of large credit card purchases over a long lifetime ($2 million to 5 million value as a bank customer).
On the other hand, restaurant customers, for example, offer only low volumes of small credit card purchases over a short lifetime (no value or value-destroying bank customer).
The CEO of the bank was very surprised to see the stark differences in customer value by industry. We also were able to show him that much of his recent growth came from value-destroying customers. The next question was: why was he adding so many “bad” customers?
Sales Force Incentives
Further analysis showed that the bank’s sales force was generating a much higher return on their pursuit of small, low-volume, short-life merchants, for three reasons:
Our conclusion: The sales force compensation plan was actually incentivizing salespeople to sign up value-destroying customers.
Revamping Sales Force Compensation: A 3-Step Program
Once we identified the problems in the compensation plan, the fixes were fairly straightforward:
Step 1: Realign commissions much more closely to customer value. Our goal with the revamped plan was to pay a consistent percentage (roughly 20 percent) of customer value as commission. Under this plan, a mid-sized hotel customer (200 rooms, $5 million of credit card charges per year) that was worth $20,000 to the bank would generate a $2,000 commission. A small shop ($2 million of credit card charges per year) that was worth only $1,800 to the bank would only generate a $180 commission. This resulted in a dramatic increase in commissions for the most attractive customers.
Step 2: Pay out the commission over three years (and pay less if the customer attrites early). Because customer value was highly linked our ability to retain them, we wanted the sales force to share the risk that the customer would leave.
Step 3: Re-price the value-destroying customers. Many customers simply could not create value, even before we paid commissions. They simply had too-few, too-small transactions over too short a lifetime with the bank. For example, a modestly priced restaurant might have an average credit card bill of $40 and only have 20 credit card transactions per day. Also, industry data and the bank’s own experience suggested that the restaurant was likely to go out of business within two years. Over those two years, they might generate $600 of fees but incur $1,000 of costs. For these customers, we added a large upfront surcharge and paid very low commissions. In essence, we actively discouraged the acquisition of those customers.
The net effect was a dramatic decrease in the signing of unattractive customers. We also saw a couple of happy side effects:
We projected these changes would increase the value of the business from the $11-12 per share it was trading at before the new plan took effect to roughly $18. A year after our engagement, the company was acquired at $18 a share